The Rs 11,300 crore was unearthed only after PNB employee Gokulnth Shetty, who had allegedly colluded with Nirav Modi in procuring fake letters of undertaking (LOUs), retired recently

Nirav Modi, and the firms he controls, allegedly leveraged the loopholes in the banking system by seeking letters of undertaking (LoU) and raising credit from foreign banks to pay its merchants. An LoU is a bank guarantee issued for overseas import payments. For past seven years, Nirav Modi and his three firms-Diamond R Us, Solar Exports and Stellar Diamonds-were allegedly procuring the LoUs from the PNB's Brady Road branch. These bank guarantees allegedly helped Modi raise the short-term loans from foreign branches of Indian banks to pay to its suppliers of raw material (rough stones). PNB shares closed 2% lower at Rs 125.65 against the previous day's closing on BSE. The money was transferred through a maze of sorts. Here is how

PNB Rs 11,300 Crore Fraud Explained In 10 Points:

There is a provision of bank guarantee known as a letter of undertaking (LOU) under which a bank can allow its customer to raise money from another Indian bank's foreign branch in the form of a short term credit. The LOU serves the purpose of a bank guarantee.

However, to be able to raise the LOU, the customer is supposed to pay margin money to the bank issuing the LOU and accordingly, he is granted a credit limit. But in Nirav Modi's case, neither was there a credit limit, nor did he ever give any margin money, reported Reuters.

Nirav Modi, via his three firms, Diamond R Us, Solar Exports and Stellar Diamonds, managed to pay to its suppliers of rough stones on a regular basis. The payment was made through the loans by banks including Axis Bank, UCO Bank (Rs 2,636 crore) and Allahabad Bank (around Rs 2,000 crore). The loans were raised by Nirav Modi's firms on showing the letters of undertakings issued by the PNB.

Incidentally, there was no official record of such letters of undertaking in the PNB records as the bank discovered early this year before reporting the matter to the CBI.

Ideally, Nirav Modi and his firms are supposed to repay the loans but so far, all these loans have allegedly been rolled over for want of funds. In the scenario when the borrower fails to make the repayment, the bank issuing the LOU (PNB in this case) is duty-bound to honour the commitments on the behalf of its customers.

So in effect, Indian bank's foreign branches make payment to Nirav Modi's suppliers in the form of loans to Modi. As guarantee, the firms show the letters of undertaking issued by the PNB's Brady Road branch in Mumbai.

In January, the fraud was unearthed when Modi's firm requested further LOUs for paying the overseas suppliers. On this, the bank officials refused on the ground that Modi's firm need to keep 100% collateral for the same. The Modi's firm argued that no such money was kept 'on margin' in the past either. Following which, the bank officials scanned the records only to discover that there was no trace of any such transaction. This implies that the guarantees/ undertakings were issued by bypassing the rules in collusion with some PNB employees.

The violation of banking rules as mentioned in the point 8 above was too glaring a blunder to ignore. Hence, Punjab National Bank filed a criminal complaint with the CBI on January 29 accusing Nirav Modi and others of defrauding the bank and causing it a loss of Rs 280 crore ($43.8 million). The complaint was filed against three companies and four people, including Nirav Modi and Mehul Choksi, managing director of Gitanjali Gems.

"We will get back to normalcy within six months. Bank has the size and capacity to come out of the problem," Sunil Mehta, Managing Director and Chief Executive Officer of Punjab National Bank. told a investors' conference call on Friday. The bank was going through some problems but "we will fix it," he added.

The Reserve Bank of India (RBI), meanwhile, said on Friday it has undertaken a supervisory assessment of control systems at Punjab National Bank and will take "appropriate supervisory action"